The refusal rate, the waiver rate and the days lost, turned into money on one fictional export order, and set against the bank and country risk the credit was bought to remove.
A discrepancy mostly costs time, and time costs interest on the goods you have already paid for. On the illustrative 4,200,000 export order of Trade Finance, with 62 per cent of first presentations refused and 94 per cent of refusals waived, the expected cost is 6.82 days of financing, or 5,447, plus 2,162 of expected loss on the refusals that are not waived: 7,609 per shipment, 2.48 per cent of the operating margin. Each refused presentation costs about 12,273 in expectation.
Worked in full in Trade Finance by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Under a documentary credit, the bank pays against documents that comply, not against goods. When a presentation does not comply, the nominated bank refuses it and the payment undertaking is suspended. Three things can then happen: the exporter corrects the documents and re-presents within the validity, the applicant waives the discrepancy and the bank pays, or the applicant refuses to waive and the exporter is left holding a claim on the buyer with no bank behind it. The first two cost days. The third costs credit risk.
Harrowgate Instruments ships 4,200,000 of instrumentation to Meridian Process Holdings on a usance credit payable 90 days after sight, unconfirmed, held to maturity, so a late acceptance pushes maturity back too. The figures are the book's working assumptions and are illustrative.
| Input | Value |
|---|---|
| Contract value | 4,200,000 |
| Cost of goods financed (81.5% of price) | 3,423,000 |
| Exporter's cost of funds, actual/360 | 8.4% |
| First presentations refused on a discrepancy | 62% |
| Of those, waived by the applicant | 94% |
| Days lost per correction cycle | 11 |
| Extra days carried on an unwaived refusal | 60 |
| Buyer one-year PD; loss given default | 4.1%; 62% |
| Operating margin before finance | 306,600 |
Step 1: the expected delay. Every refusal costs one correction cycle of 11 days, and it happens on 62 per cent of presentations.
Expected delay = 62% × 1 × 11 = 6.82 days
Step 2: the delay in money. The exporter's own facility funds the cost of the goods, not the invoice, at 798.7 a day.
Delay cost = 3,423,000 × 8.4% × 6.82 ÷ 360 = 5,447
Excel: =COGS*CoF*Refuse*Cycles*DaysPerCycle/360
Step 3: the refusals that are not waived. They are 62 per cent of the 6 per cent that the applicant does not waive, 3.72 per cent of presentations. On those, the exporter carries the buyer unsecured for the exposure period of 136.82 days (transit, documents, bank handling, expected delay and the 90-day term) plus the 60 days it takes to argue the refusal out.
Buyer PD over 196.82 days = 1 − (1 − 4.1%)196.82/365 = 2.232%
Expected loss = 4,200,000 × 3.72% × 2.232% × 62% = 2,162
Step 4: add them. 5,447 + 2,162 = 7,609, which is 0.18 per cent of the price and 2.48 per cent of the operating margin.
Seen per refused presentation rather than per shipment: 11 days of financing is 8,786, and if the refusal is not waived the buyer's expected loss over the period is 58,126; at a 6 per cent chance of no waiver that is 3,488. Each refusal is worth about 12,273, or 4.0 per cent of the operating margin.
The credit was bought to replace the buyer's risk with the issuing bank's and the country's. Over the same 136.82 days, the chance that one of them fails is 1.18 per cent, against 3.72 per cent for an unwaived refusal: the document risk is 3.1 times more likely. But a failed bank pays nothing, while a waived refusal pays late, so the expected losses run the other way.
| Risk | Probability | Expected loss |
|---|---|---|
| Refused and not waived | 3.72% | 2,162 |
| Issuing bank or country fails | 1.18% | 30,813 |
Quoting the 3.1 ratio without the two expected losses beside it gets the comparison backwards: in expected loss, bank and country risk is 14.3 times the document risk. The honest description is that the credit trades a small chance of a large loss for a large chance of a small delay.
| Case | Expected delay, days | Delay cost | Expected loss | Total |
|---|---|---|---|---|
| Refusals 0% | 0.00 | 0 | 0 | 0 |
| Refusals 20% | 2.20 | 1,757 | 681 | 2,438 |
| Refusals 40% | 4.40 | 3,514 | 1,378 | 4,892 |
| Refusals 62%, waived 94% (base) | 6.82 | 5,447 | 2,162 | 7,609 |
| Refusals 80% | 8.80 | 7,029 | 2,818 | 9,846 |
| Waived 80% | 6.82 | 5,447 | 7,208 | 12,655 |
| Waived 50% | 6.82 | 5,447 | 18,019 | 23,466 |
| Two correction cycles per refusal | 13.64 | 10,894 | 2,236 | 13,131 |
The refusal rate is the exporter's own lever: a checking routine that cuts refusals from 62 to 20 per cent is worth 5,171 per shipment of this size. The waiver rate is the buyer's lever, and it is the one to watch. A buyer that uses discrepancies to renegotiate price or delay payment can move the waiver rate from 94 to 50 per cent, and the expected loss rises more than eightfold to 18,019. At that point the document risk is most of the way to the 30,813 the credit was meant to remove.
The common mistake is to count only the discrepancy fee the bank deducts and call that the cost. The fee is visible; the days are not, and on a large order they are worth far more. The opposite mistake is to treat the high refusal rate as proof that letters of credit do not work: most refusals are waived, and the instrument still removes far more expected loss than it introduces. Confirmation does not help here, because a confirming bank is bound only by a complying presentation; whether paying for it is worth it is worked in is a letter of credit confirmation fee worth paying. The document risk sheet, with every input above in a blue cell, is in the free workbook for this order.
The bank refuses the presentation and the payment undertaking lapses until the discrepancy is cured or the applicant waives it. Most refusals end in payment, only later. On an illustrative order with 94 per cent of refusals waived, a refusal costs 11 days of financing, 8,786 on 3,423,000 of goods at 8.4 per cent, plus a 6 per cent chance of carrying the buyer's credit risk unsecured.
More likely, much less costly. On an illustrative 90-day credit the chance of a refusal that is not waived is 3.72 per cent, 3.1 times the 1.18 per cent chance that the issuing bank or the country fails. But the expected loss from documents is 2,162 against 30,813 for bank and country, because a waived refusal still pays.
On an illustrative 4,200,000 order, cutting first-presentation refusals from 62 to 20 per cent saves 5,171 per shipment in financing and expected loss; eliminating them saves 7,609. A second correction round on every refusal would raise the cost to 13,131. At that scale, checking documents before presentation can pay for itself on a single shipment.
This article is one calculation from Trade Finance. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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